Global Macro: Markets React to Improved Economy

TheStreet.com

NEW YORK (TheStreet) -- U.S. equity markets surpassed record highs on Friday, pricing in stronger economic data and an improved outlook for the second half of 2013.

The nonfarm payrolls number was softer than many analysts had expected, but the unemployment rate dipped toward 7%. Overall, the economic picture looked to be improving considering this past month's batch of releases.

The real question is whether financial markets believe the Federal Reserve will begin tapering in September or later. A close look at financial markets provides some clues about what the majority of market participants believe will happen during the remainder of 2013.

The first chart below is of Guggenheim S&P 500 Equal Weight over SPDR S&P 500 .

This pair measures the market breadth of the S&P 500. Economic data this week vastly outperformed expectations. Similarly, on a global front, Chinese manufacturing data came in better than expected, and European purchasing managers indices similarly beat expectations.

With the positive news flow, a majority of U.S equities pushed higher. The S&P 500 currently resides at record highs, above the 1700 level. This trend should continue as investor sentiment continues to improve and money moves off the sidelines and into the market.

The next chart is iShares Russell 2000 Index over iShares Russell 1000 Index . This pair tells a slightly different story than the chart above.

Small-cap stocks have led indices higher, which is a bullish sign for equity markets. The issue that we currently face, however, is that the leadership has corrected sharply lower after running up against resistance levels.

The pair is at record levels as well, yet to continue its strong move higher, price action must break above its highs. If the pair begins a trend downward, look for equity indices to follow suit and correct to lower levels. Defensive sectors such as utilities and health care would begin showing relative leadership in this environment.

The last chart is of iShares Barclays 1-3 Year Treasury Bond over iShares Barclays 20+ Year Treasury Bond . This pair measures the Treasury yield curve through financial market movements. As the price action increases, it signals a steepening in the curve.

The curve has drastically steepened as an end to accommodative monetary policy has been priced into financial assets. Investors have sold off longer-dated bonds in expectation of rising future rates.

The pair ran up against resistance in July but has since broken higher.

With a mixed number from nonfarm payrolls this Friday, investors questioned what this meant for quantitative easing. It looks as if the strong economic data from earlier in the week, however, has managed to confirm the belief that the Fed will most probably rein in bond buying by its September meeting.

Equity markets look to have shaken off higher rates, and now consider the stronger data that justifies a steepening curve a bullish indicator for stocks.

At the time of publication, Sachais had no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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